New budget has significant tax-planning impact

Although pundits described the March 21, 2013, federal budget as a "sleeper," there are actually a lot of measures aimed at people who do effective tax planning.

If any of these items rings a bell with your situation, do a bit more investigation or talk to your professional advisers. These provisions are not law until the budget passes Parliament and the Senate, but nevertheless many took effect March 21, pending such passage.

Life insurance

Policy arrangements that involve borrowing, either to fund a stand-alone policy or an insured annuity (called a "triple back-to-back" annuity) have tax benefits, primarily a deduction for interest expense on the loans, and tax sheltering of the accrual or growth earned by the cash values.

The budget will eliminate these tax advantages for loans entered into after budget day for leveraged insured annuities. For so-called 10-8 insurance policy arrangements, interest paid after year-end 2013 will not be deductible.

We can understand the denial of interest deductibility on loans that do not generate taxable investment income. I get that. But an apparently punitive measure also introduced for both these strategies is to deny the usual increase in a private corporation's capital dividend account by the amount of the death benefit received. This is what allows the tax-free payment of life insurance proceeds on death to shareholders of corporations.

Such policies can be brought onside by paying off the loans or, with 10-8s, apparently brought in line by uncoupling the reference of the borrowing rate from the guaranteed rate of return in the policy.

As well, the budget allows for unwinding such policies before year-end without any negative tax consequences -- the government's acknowledgement that the tax rules clearly allowed these plans to be set up at the time they were arranged.

Tax-advantaged investments

A number of mutual funds and other vehicles have been successful at effectively converting fully taxable interest income on guaranteed investments into capital gains, which are taxed at half the rate. Returns from these "Character Conversion Transactions," as the budget calls them, will now be treated as regular income if set up on or after budget day, or have an agreement extended after March 21.

Regular corporate-class mutual funds do not appear to be touched by this. However, "Synthetic Dispositions" and monetization of assets, which essentially allowed a person to dispose of a property without selling it for tax purposes, are to be eliminated.

Through tinkering with the dividend tax credit on non-eligible dividends (generally those paid from private corporations to their shareholders), the top federal tax rate will rise after 2013 from 19.58 per cent to 21.22 per cent, plus applicable provincial tax. (Manitoba made a similar punitive change in its 2012 budget, compounding this tax rate increase.)

Starting immediately, the tax deduction for investors with a safety deposit box will be eliminated. The tax credit for investing in labour-sponsored venture capital corporations will be phased out in 2016.

Potential bad news for people with carefully planned estates is that the government is proposing to "consult" on the long-held availability of the graduated tax rates to testamentary trusts. As this could negatively impact many beneficiaries, I encourage affected people to respond to the government request for input and opinions.

Since this is a tax advantage that people have to be willing to die to obtain for their heirs, no one should classify it as a freebie.

Better news is the overdue expansion of the lifetime capital gains exemption on qualifying farm, fishing and small-business corporation shares, from $750,000 to $800,000, with future indexing to inflation.

There is also a new "super credit" for first-time donors to charity, on the first $1,000 of donations made after budget day in any one year. This can save qualifying donors up to $230 of tax on a $1,000 donation.

Well, it's something...

Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

David Christianson, BA, CFP, R.F.P., TEP, is a financial planner, adviser and vice-president with National Bank Financial Wealth Management and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.

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